Kinky Demand Curve:
A kinky demand curve is a type of demand curve that exhibits an abrupt change in slope at a particular price level, rather than a smooth, continuous slope as seen in most standard demand curves. The kink in the curve indicates that the price elasticity of demand changes significantly when the price crosses a certain threshold. This concept is commonly associated with oligopolistic markets where firms face competition, but with some degree of market power.
Characteristics of a Kinky Demand Curve:
1. Discontinuity in Elasticity: A kinky demand curve typically has two distinct segments: one that is more elastic (flatter) and another that is more inelastic (steeper). The elasticity of demand changes sharply at the "kink" point, which is often associated with a price level at which firms expect competitors to react.
2. Price Rigidity: The kink represents a situation of price rigidity or sticky prices, where firms do not want to change their prices due to the expected response of competitors. For example, if a firm lowers its price, it assumes competitors will follow suit, leading to a relatively elastic demand. However, if a firm raises its price, it assumes that competitors will not raise their prices, resulting in a relatively inelastic demand for its product.
3. Oligopoly and the Kinked Demand Curve Model: The concept of a kinky demand curve is primarily used in the kinked demand curve model of oligopoly. In this model, firms in an oligopoly market are interdependent and base their pricing decisions on the expected reactions of their competitors.
- Price Decrease: If a firm decreases its price, competitors will also reduce their prices to maintain market share, and demand becomes more elastic.
- Price Increase: If a firm raises its price, competitors will not follow, leading to a sharp decrease in demand for the firm’s product, making the demand curve more inelastic above the kink.
4. Market Stability: The kinked demand curve suggests that prices in an oligopolistic market tend to be stable because firms are reluctant to change their prices. A firm’s desire to avoid losing market share or triggering a price war leads to price rigidity in the market.
Illustration:
- Above the Kink (Price Increase): If the price is above the kink, demand is relatively inelastic because competitors are not likely to raise their prices in response, causing a significant loss in market share for the firm.
- Below the Kink (Price Decrease): If the price is below the kink, demand is more elastic because competitors will lower their prices to match the price reduction, increasing the firm's sales.
Conclusion:
The kinky demand curve is a model used to describe price behavior in an oligopoly where firms face different elasticities depending on whether they increase or decrease their prices. This results in price stability, as firms avoid price changes to prevent undesirable competitive responses. The kinked demand curve reflects the reality that firms in oligopolistic markets are interdependent and base their pricing decisions on expected competitor actions.
Subscribe on YouTube - NotesWorld
For PDF copy of Solved Assignment
Any University Assignment Solution
.webp)
